Sat, Jan 08, 2011 - Page 9 News List

Demographics lie at the heart of the ‘Japan myth’

By Daniel Gros

The first decade of this century started with the so-called dot-com bubble. When it burst, central banks moved aggressively to ease monetary policy to prevent a prolonged period of Japanese-style slow growth. However, the prolonged period of low interest rates that followed the 2001 recession instead contributed to the emergence of another bubble, this time in real estate and credit.

With the collapse of the second bubble in a decade, central banks again acted quickly, lowering rates to zero (or close to it) almost everywhere. Recently, the US Federal Reserve has even engaged in an unprecedented round of “quantitative easing” in an effort to accelerate the recovery. Again, the key argument was the need to avoid a repeat of Japan’s “lost decade.”

Policymaking is often dominated by simple “lessons learned” from economic history. However, the lesson learned from the case of Japan is largely a myth. The basis for the scare story about Japan is that its GDP has grown over the past decade at an average annual rate of only 0.6 percent, compared with 1.7 percent for the US. The difference is actually much smaller than often assumed, but at first sight a growth rate of 0.6 percent qualifies as a lost decade.

According to that standard, one could argue that a good part of Europe also “lost” the past decade, since Germany achieved about the same growth rates as Japan (0.6 percent) and Italy did even worse (0.2 percent); only France and Spain performed somewhat better.

However, this picture of stagnation in many countries is misleading, because it leaves out an important factor, namely demography.

How should one compare growth records among a group of similar, developed countries? The best measure is not overall GDP growth, but the growth of income per head of the working-age population (not per capita). This last element is important because only the working-age population (WAP) represents an economy’s productive potential. If two countries achieve the same growth in average WAP income, one should conclude that both have been equally efficient in using their potential, even if their overall GDP growth rates differ.

When one looks at GDP/WAP (defined as population aged 20 to 60), one gets a surprising result: Japan has actually done better than the US or most European countries over the last decade. The reason is simple: Japan’s overall growth rates have been quite low, but growth was achieved despite a rapidly shrinking working-age population.

The difference between Japan and the US is instructive here: In terms of overall GDP growth, it was about 1 percentage point, but larger in terms of the annual WAP growth rates — more than 1.5 percentage points, given that the US working-age population grew by 0.8 percent, whereas Japan’s has been shrinking at about the same rate.

Another indication that Japan has fully used its potential is that the unemployment rate has been constant over the past decade. By contrast, the US unemployment rate has almost doubled, now approaching 10 percent. One might thus conclude that the US should take Japan as an example not of stagnation, but of how to squeeze maximum growth from limited potential.

Demographic differences are relevant not just in comparing Japan and the US, but also in explaining most of the differences in longer-term growth rates across developed economies. A good rule of thumb for the average growth rates of the G7 countries would be to attribute about 1 percentage point in productivity gains to the growth rate of the working-age population. The US has done slightly worse than suggested by this rough measure; Japan has done a bit better; and most other rich countries come pretty close.

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